In the recent judgment of Tianrui (International) Holding Company Ltd (Appellant) v China Shanshui Cement Group Ltd (Respondent),[1] delivered on 14 November 2024, the Judicial Committee of the Privy Council (“JCPC”) considered the question of whether a shareholder has a personal claim against a company in circumstances where the directors of the company have exercised their powers for an improper purpose.
The JCPC ultimately allowed the appeal, finding that a shareholder has a right of action against the company to challenge the allotment of shares by the board of directors on the basis that the allotment was made for an improper purpose in circumstances where the allotment will cause detriment to the shareholder.
Background
The background to the dispute concerns a long-standing battle for control of the respondent company, China Shanshui Cement Group Ltd (the “Company”), a Cayman exempted company registered in Hong Kong as a non-Hong Kong company and listed on the Hong Kong Stock Exchange. The Company is a holding company of operating subsidiaries registered in Hong Kong and the People’s Republic of China (“PRC”), with the group being principally engaged in the production, distribution and supply of cement in the PRC.
The appellant, Tianrui (International) Holding Company Ltd (“Tianrui”) is a company incorporated in the British Virgin Islands with a shareholding of 28.16% of the Company. The other major shareholders of the Company are Asia Cement Corporation (“ACC”) with a 26.72% shareholding, China National Building Materials Co Ltd (“CNBM”) with a 16.67% shareholding, and China Shanshui Investment Company Limited (“CSI”) with a 25.09% shareholding.
In around May 2018, a majority of shareholders of the Company, including ACC, CNBM and CSI, voted at an extraordinary general meeting (“EGM”) of the Company to reconstitute the board of directors, with the reconstituted board comprising one director from CNBM, one director from ACC and three independent non-executive directors.
In or around August and October 2018, the Company issued convertible bonds in two tranches. At a subsequent EGM, a majority of shareholders passed a resolution mandating the directors to allot and issue new shares in the Company to the holders of the convertible bonds.
Tianrui alleged that the bondholders were parties connected to or affiliated with ACC and CNBM and that the issuance and allotment of shares was for the purpose of diluting Tianrui’s shareholding and obtaining control of the Company. Tianrui’s shareholding was decreased from 28.16% to 21.75%, with the result that Tianrui could no longer block special resolutions as its shareholding was under 25% and that, if the share issuance was valid, Tianrui could not prevent the merger of the Company and may have to have its shares bought out under s.238 of the Companies Act.
Tianrui commenced a writ action against the Company, seeking declarations that the exercise by the directors of the Company of the powers (i) to issue the convertible bonds, (ii) to convert the bonds into shares, and (iii) to issue the new shares, were not valid exercises of the relevant powers. The Company sought to strike out Tianrui’s claim as an abuse of process on the basis that Tianrui did not have standing to sue the Company for claims concerning alleged breaches by the directors of their fiduciary duties owed to the Company.
In the first instance decision in the Grand Court, Segal J rejected the argument that a shareholder did not have a personal claim because the shareholder could obtain redress by a derivative action, declining to follow the Court’s earlier decision in Gao v China Biologic Products Holdings, Inc [2018 (2) CILR 591] where the Court struck out a writ by a minority shareholder challenging the exercise of powers by a board of directors on the ground that the plaintiff lacked standing. Segal J held that Tianrui did have standing to bring a claim against the Company for improper dilution.
The Company appealed to the Court of Appeal, with the central question for the Court of Appeal being whether a minority shareholder had standing to sue the company in which it held shares in the face of two possible obstacles: first, that directors owe their fiduciaries duties to the company which appoints them and not to its shareholders, and secondly, the view that the damage suffered as a result of a breach of fiduciary duty by the directors is damage to the company itself, and not to the shareholder whose voting power has been diminished by the issue of new shares.
The Court of Appeal allowed the appeal, concluding that it remained Cayman law that an aggrieved shareholder has no personal right of action against the company and must found their claim on a basis that is consistent with the rule in Foss v Harbottle or with the fraud on the minority exception to that rule (discussed further below).
Privy Council decision
Tianrui then appealed to the JCPC, which heard the appeal in March 2024.
Issues for determination
The central issues for the JCPC’s determination were as follows:
- In circumstances where the duty of the directors alleged to have been breached is owed to the company, and not to its shareholders, what, if anything, is the shareholder’s cause of action?
- What, if any, distinctive aspects of the shareholder’s cause of action mean that it may be pursued notwithstanding the rule in Foss v Harbottle?
- Was the impugned exercise of the board of directors’ power void or voidable?
- Was the alleged breach of duty capable of being ratified by a majority of the company’s shareholders? If so, what is the consequence of the theoretical availability of ratification for the pursuit of the shareholder’s claim in the meantime?
JCPC’s findings
The JCPC ultimately allowed the appeal, finding that a shareholder has a right of action against a company where the board of directors has allotted shares for an improper purpose and this has negatively affected the shareholder. Accordingly, the JCPC held that the writ against the Company should not have been struck out and should be reinstated.
The JCPC recognised that the underpinning challenge by the Company to the right of Tianrui to bring the proceedings was the rule in Foss v Harbottle, made up of two related principles:
- First, where a wrong has been done to a company, only the company, not an individual shareholder, can take action. A breach by a director or by the board of directors of a duty which is owed to the company is a wrong done to the company, and the general rule is that only the company has a remedy for that breach.
- Secondly, the will of the majority of the shareholders of the company should, as a general rule, prevail in the running of the company’s business. Thus, if a transaction can be made binding on the company by a simple majority of shareholders, and that majority does not want to take action against a director or directors for breach of duty in relation to it, the majority can, as a general rule, waive the breach or ratify the irregular acts of the director or directors.
The exception to the operation of these principles is where the wrongdoers are themselves in control of the company. In that event, which is often called “fraud on the minority”, the aggrieved shareholder can bring a derivative action seeking relief on behalf of the company in which the cause of action is vested.
The JCPC reviewed the leading cases in England and Australia considering the exercise by directors of their powers for an improper purpose, citing the decisions of, inter alia, Punt v Symons & Co Ltd [1903] 2 Ch 506, Hogg v Cramphorn Ltd [1967] Ch 254, Bamford v Bamford [1970] Ch 2012, Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821, Ngurli Ltd v McCann (1953) 90 CLR 425, and Residues Treatment & Trading Co Ltd v Southern Resources Ltd (1988) 6 ACLC 1160. The JCPC highlighted that these cases had not considered the jurisprudential basis for a shareholder’s standing to bring a personal claim against a company.
In coming to the view that a shareholder whose holding is diluted by an improper allotment of shares by the directors may bring a personal claim against the company challenging the validity of that allotment, the JCPC adopted a “first principles” approach and provided the following analysis:
- The basis of a shareholder’s right to bring an action against the company to challenge an improper exercise of the directors’ powers to allot and issue shares is the contract between the shareholder and company set out in the memorandum and articles of association. The conferment upon the directors of its fiduciary powers to allot and issue shares is an important part of the contract between shareholders and the company, and it is implicit that the exercise of such fiduciary powers must be for a proper purpose.
- The right of a shareholder to sue the company is not dependent upon the alteration in the balance of power being adverse only to a minority of shareholders, nor is the personal right to sue dependent on the claiming shareholders being, or being part of, a majority. The JCPC considered that the size of the claimant’s shareholding was in principle irrelevant, and what mattered was that the claiming shareholder suffered an interference with its shareholder rights brought about by the improper share issue and allotment.
- It is irrelevant whether the company itself had a cause of action against the directors for a breach of duty owed to it. A shareholder’s action against the company could coexist with an action by the company in respect of the same breach of duty by the directors, so that the availability of the latter by no means excludes the former.
- Shareholders of a solvent company may, acting unanimously, ratify any action taken by the directors which falls within the corporate capacity of the company itself. However, if the shareholders seek to use their power to act by a majority, then they are constrained by the equitable principle that they may not do so by way of oppression of the dissenting majority and that constraint is inherent in the power of the majority of a class to bind the minority. Accordingly, the theoretical possibility of ratification was not sufficient to deprive a claimant shareholder of a cause of action.
Applying its analysis of the relevant principles, the JCPC concluded that the facts of this appeal presented a strong case for the availability of the shareholder’s personal action against the Company, finding that the writ should not have been struck out by the Court of Appeal and allowing the appeal.
Comment
The JCPC’s judgment provides welcome guidance on the ability of an aggrieved shareholder to bring a personal claim against a company in circumstances where a breach of fiduciary duty is alleged to have occurred, particularly where there has been an issuance and allotment of shares for the improper purpose of diluting the shareholder’s holding in a company.
The decision is also a significant development of the rights of shareholders in the Cayman Islands where there are no standalone statutory remedies available for minority oppression or unfair prejudice and where any shareholder remedies are largely obtained through the just and equitable winding up and/or derivative action regime, which may not always be fit for purpose in the circumstances of the case.
It remains to be seen whether the ability of a shareholder to bring a personal claim where their rights have been infringed is expanded outside of the context of improper dilution and what impact ratification may have to defeat personal claims of shareholders.
[1] Tianrui (International) Holding Company Ltd (Appellant) v China Shanshui Cement Group Ltd (Respondent) [2024] UKPC 36 (“JCPC Judgment”).
